Same old dance?

Commentary: Fundamentals, approvals drive biotech rally

LOS ANGELES (CBS.MW) -- Biotech stocks are gathering steam again after two years of steep declines. The volatile sector has seen wildly bullish swings before, only to see such rallies crash as swiftly as they had run up.

John McCamant is excited about the potential for a rally with real staying power this time. McCamant's Medical Technology Stock Letter shined in previous biotech rallies, scoring triple-digit gains in 1999 and 1995.

Last year, however, the two model portfolios featured in the Berkeley, Calif.-based newsletter combined for an average loss of 66 percent, according to the Hulbert Financial Digest. By comparison, the Amex Biotech Index tumbled 42 percent and the Wilshire 5000 slipped 21 percent.

But 2003 may prove to be another banner year with his portfolios up 63 percent through May (see HFD data) vs. a 33 percent gain by the Biotech index
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CBS MarketWatch spoke with McCamant to find out why he thinks this time the rally could be for real.

The Amex Biotechnology Index has rallied roughly 56 percent from the March low. Any reason we should think it's for real this time?

What we've had this year is driven by fundamentals. One of the keys has been an improving environment at the FDA. It's the best we've ever seen as far as getting things out -- but also communicating clearly with companies on how and what they need to do to get products approved. So we've had the approvals, AstraZeneca's
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Iressa, Velcade from Millennium
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and others -- and more approvals to come.

But the one event that has probably made the biggest difference in biotech this year was the Avastin antiangiogenesis drug from Genentech
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That surprised everybody, including ourselves, even though we were long Genentech at the time.

We didn't believe that drug was going to work that fast. This is a potential multi-million dollar drug. The only one in its class that will be approved this year.Antiangiogenesis is the process of starving tumors. Cutting off their vasculature, feeding the blood vessels, which contributes to out of control cell growth, the hallmark of cancer.

We've heard about these miracle pharmaceuticals before...

I would not use the word miracle. We don't expect to cure cancer. What we're looking at is closer to what we've done with HIV. HIV is now treated as a chronic disease for the most part, particularly because of all the tools, multiple drugs used in combination.

So this is a new mechanism that can be added to other tools. In fact, their data was generated in combination with chemotherapy. So we're not replacing the old cancer tools, we're adding to the armamentarium of the oncologist.

It just seems that whenever there's a sudden surge in biotech, we can usually point to a handful of new drugs that people get very excited about -- and then the rally fizzles.

I think what a lot of people don't fully appreciate is the size of the sector. There's that many more products approved now than there were three years ago. There's that many more in late-stage development.

So we used to have 10 profitable biotechs. Now we're closer to 30 or 40. We used to get a couple of approvals a year, now we're looking at 20 approvals in a year. It's never been this mature. The fundamentals have improved significantly.

Have they improved enough to justify all of the current run? I believe so. We had two full years of negative appreciation and during that period, not one company stopped working. These aren't like they sold less chips or quit innovating like a tech company. So the values were still being created whether or not they were being reflected in the underlying stock prices.

There was another pharmaceutical that surprised recently. Erbitux may finally see FDA approval.

I would beg to differ. Over a month ago, the German company Merck KGaA said they had good data. In addition, the data was confirmed by an independent monitoring board. I'm not sure why Wall Street didn't believe this. This is a reputable, good size German pharmaceutical company that said they had good data.

Erbitux is, of course, the Imclone cancer drug that landed founder Sam Waksal and domestic diva Martha Stewart into that insider-trading mess. What's your take on the situation?

Kudos to Sam and his brother Harlan for their fortitude and sticking with that company when very, very few people believed, particularly in the mid-'90s. Without their vision, Erbitux probably wouldn't be coming to the market today.

As Sam sits in prison next year, I believe his drug will be making a tremendous benefit for cancer patients.

(Unlike other scandals in the news) Imclone
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doesn't have one person that lost their retirement plan. No one lost their job because of Sam. He made some big mistakes. There's no question. But what did he do that was so horrible that ruined a company?

You sold off your Imclone position at the end of May, early June.

We sold our Imclone during the ASCO (American Society of Clinical Oncology) conference in the high $30s. It's in the high 30s now. No regrets. It can go higher but at the same time, the stock was $14 a month ago. It almost tripled.

You used most of your Imclone proceeds to beef up your position in Nuvelo.

Nuvelo
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is George Rathmann's third company. He founded Amegen, then ICOS.

It's a transition genomics company, they still have some genomics assets but they brought Dr. Ted Love from Genentech -- who's very good at cardiovascular drug development. They partnered a drug from Amgen and that's in development right now in Phase II. So it's basically a cardio vascular drug story right now.

They've been creating value in the last month so we've raised the buy limit to reflect that.

The same true for Indevus?

Indevus
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is $6 and change -- so it's well above our buy limit. It was a dollar stock last year. It still has very good fundamentals but it's got a lot of air in it.

It's improving its story regularly and its fundamentals continue to improve. It has filed its drug, Trospium, with the FDA for approval. It's an overactive bladder drug. It's a very, very nice substitute for Depends diapers.

It's approved in Europe. It's got a large database of safety. It's probably as close as you get to a slam-dunk for approval with the FDA. We think it continues to be a very good buy under $5.

Given past volatility in the sector, what can investors do to minimize risk?

I think one of the broad principals for biotech investors is diversification. We do that two ways. One of them is by having enough names to spread the risk. Maybe it's five for some people but probably closer to 10.

We also believe that you should spread some of the risk and some of the reward by investing in the different tiers.

Tier one companies are basically profitable biotechs that are very large market cap. A little less risk there, but maybe a little less reward. The second tier is the middle names in biotech, at roughly between $150 million and the $500 million range. In the third tier are the $100 million range names and those have much more upside but additional risk.

Drug development still has an extremely high beta attached to it, but the powerful fundamentals of an improved pharmaceuticals sector -- one of the closest things we have to a monopoly in this country -- provide tremendous earnings power and tremendous margins for these companies.

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